If you don’t save money for your retirement, you could end up helpless and dependent on other people in your old age. Fortunately, there is a simple way to figure out how much money you need to save for retirement that does not require a lot of complex formulas or assumptions on your part.
First, add up all of your current expenses and financial liabilities. Next, add up all of your future expected liabilities. For example, if you expect to take care of your spouse in her old age, then you would need to adjust your liabilities to assume that you will be the only one drawing an income. If you expect to travel when you retire, this would be another expense to figure in.
Since it’s difficult to know exactly how much future expenses will be, assume that all future expenses in today’s dollars. In other words, assume that you’re going to retire tomorrow, and you need to provide for all of your retirement needs right now. Subtract any other income you expect to receive from the total amount of your expenses. For example, if your expenses total $40,000 for the year, but you expect to receive a $12,000 annual Social Security income benefit, then subtract $12,000 from $40,000 since Social Security will pay for part of your total expenses.
Next, write down the age at which you want to retire. Calculate this in terms of how many years you must save. For example, if you’re 35 and you want to retire at 65, then you have 30 years of saving ahead of you.
Think about how much you can realistically earn through investing. For most people, the interest rate you should assume will be a fixed rate and not a variable rate. Investing in the stock market does come with potentially higher returns than investing in bond-based investments. However, it also adds a level of uncertainty about how much you ultimately need to save over the long-term. Since a stock market correction can dramatically increase your savings needs, assume you will invest in a fixed-interest investment over the long-term.
For example, if you think you can reasonably earn 5 percent over the long-term, use this percentage as your long-term investment interest assumption. Then divide your total expenses by the assumed interest rate you think you can achieve.
If your total current and future expenses are $40,000 per year, less $12,000 of Social Security income, then your total expenses would really only be $28,000. Then you would divide this amount by 5 percent (.05). The resulting figure is $560,000. This is the total retirement savings you must have in today’s dollars to generate $40,000 per year of income without touching your principal amount.
It’s easiest to use a simple retirement calculator, like the one available through Bloomberg (bloomberg.com/personal-finance/calculators/retirement), to figure out how much money you should save every month to meet your goal. In this example, you would need to save $8,428.80 per year to meet a retirement goal of $560,000. That translates into $702.40 per month that you need to save. You also need to factor in inflation over the next 30 years. This is simple to do. Just increase the amount of your monthly savings every year by the rate of inflation published by the U.S. Department of Labor.
Post contributed by Elizabeth Goldman, on behalf of Wonga.ca